Tax Deferred Annuity

What is Tax-Deferred Annuity?

A tax-deferred annuity is an employee retirement benefit plan where both an employer and its employee contributes to the saving plan for the purpose of long term investment growth and it offers various benefits like age 50 plus catch up, lifetime catch up, taxes and investment options.

Explanation

It is a big advantage that tax is not to be paid right now, so we can call it as a tax-sheltered annuity. This type of annuity is of two types, first single payment annuity and second is a series of payment annuity. In single payment annuity, onetime payment is made by the investor whereas, in a series of payment, annuity payments made at equal intervals.

• Tax-deferred annuity plan generally uses to manage by Insurance companies.
• Many types of annuities exist in the market with its different features and benefits.
• As per the Statutory rules till the age of 59.5 investors cannot withdraw money if the investor does so than penalty may impose for before withdrawal.
• The interest amount accumulates and tax-deferred until the money is received by the investor.
• Some companies give an option to their employees to contribute to a tax-deferred annuity plan from their salary for their Long term growth.

Formula

Given below is the formula to calculate deferred tax annuity.

• A = Amount
• i = Interest Rate
• n = Number of Payments

Examples of Tax-Deferred Annuity

Given below are the example of deferred annuity.

Example #1

Mr. Y initiated a deposit from his employer of $ 500 per month starting at the age of 55 until Mr. Y retire, say retirement age is 65. If the interest rate is 3% compounded monthly, what will be the value of the annuity at the end of 10 years?

Here, i = 3% / 12 = 0.0025

n = 12*10 =120

Calculation of annuity value is as follows –

• Deferred Tax Annuity = $500*(1+0.0025)¹²⁰ – 1 /0.0025
• =$69,870.71

Thus, the annuity at the end of 10 years of Mr. Y will be $ 69870.71/-

Example #2

Mr. Pawan initiated a deposit from his employer of $ 3000 quarterly starting at the age of 50 until Mr. Pawan retire, say retirement age is 60 years. If the interest rate is 6% compounded quarterly, what will be the value of the annuity at the end of 10 years?

i = 6% / 4 = 0.015

n = 4*10 = 40

Calculation of annuity value is as follows –

• Deferred Tax Annuity = $3000*(1+0.015)⁴⁰– 1 / 0.015
• =$162,804

Thus, the annuity at the end of 10 years of Mr. Pawan will be $162,804/-

Example #3

Mr. Devanand initiated a deposit from an employer of $5000 half-yearly starting at the age of 45 until Mr. Devanand retires, say at the age of 60. Suppose the interest rate is 8% compounded half-yearly. What will be the value of the annuity at the end of 15 years?

i = 4% / 2 = 0.020

n = 2*15 = 30

Calculation of annuity value is as follows –

• Deferred Tax Annuity = $5000*(1+0.020)³⁰– 1 / 0.020
• =$202,840.40

Thus, the annuity at the end of 15 years of Mr. Devanand will be $ 202840.40/-

Example #4

Mr. Abhinay initiated a deposit from his employer of $ 8000 yearly starting at the age of 55 until Mr. Abhinay retires, say the retirement age is 60 years. Suppose the interest rate is 8 % compounded yearly. What will be the value of the annuity at the end of 5 years?

Calculation of annuity value is as follows –

• Deferred Tax Annuity = $8000*(1+0.08)⁵– 1 / 0.08
• =$46932.81

Thus, the annuity at the end of 5 years of Mr. Abhinay will be $ 46932.81/-

Advantages of Tax-Deferred Annuity

• The investor has to pay tax only once when he withdraws the annuity amount.
• The contribution amount has no limitation whatever amount the investor wants to invest he can invest.
• This annuity provides a lifetime benefit for the investor and his/her spouse.
• This annuity having death benefit suppose investor die in between the annuity contract, the amount will be received by nominee.
• Most of the insurance companies provide a guarantee for the loss of principal.

Disadvantages of Tax-Deferred Annuity

• The investor has to bear additional charges like commission, administrative fees, funding expenses, etc.
• High income can be earned by the investor by investing money in the stock market instead of investing in an annuity.
• An investor can not withdraw money during the annuity term and if withdraw then penalty have to be paid for early withdrawal.

Withdrawal Options

When investor reaches the age of 59.5 then payment can be received in one of three ways described as below:

1. Lump-Sum: In this option, a one-time single taxable payment will be received by the investor.
2. Annuitization: In this option monthly, quarterly or yearly payment received by the investor until death.
3. Systematic Withdrawal: In this option, the amount will be paid periodically.

Conclusion

• Deferred Tax Annuity plan is a kind of investment plan where income tax on investment income is not charged during the investment term and any tax liability thereof is postponed until maturity.
• A tax-deferred annuity is a contract between the investor and an insurance company in which the insurance company receives money from an investor and pays interest on a pre-determined rate for a fixed period.
• The investor enters into this contract for saving money for the future.
• The investor receives a tax benefit for the contract period in the form of tax-deferred on earning.
• Income from this contract will be taxed as ordinary income on the withdrawal of money.
• On the death of the investor money will be received by beneficiary and taxable in the hands of the beneficiary.

Recommended Articles

This has been a guide to what is Tax-Deferred Annuity and its definition. Here we discuss the formula of tax-deferred annuities along with calculation examples, advantages, and disadvantages. You can learn more about accounting from the following articles –

• Ordinary Annuity | Examples
• Proportional Tax
• Calculate Future Value of Annuity Due
• Annuity vs Lump Sum